Friday, January 11, 2008

Liquidity Squeeze Is Opportunity

Despite the efforts of the Federal Reserve Bank of the United States and central banks in other nations, we are in a credit squeeze. In historic terms it is not much of a squeeze so far, but it could get worse if the U.S. economy enters a recession or the global economy slows down from its hot growth rate.

Credit is hard to come by, but strangely interest rates are not high and appear to be heading lower. That means cash is king. Many people who, by income or personal wealth measurements, are traditionally in the investor pool, have had to raise cash. They have had to sell what they could, and that has meant a lot of selling of good quality stocks, because those were the only liquid assets available to sell.

For those of us who saw that the housing market would decline at some point (it can hardly be said to have burst like a bubble, so far) and built up cash instead of getting deeply into debt, this is a golden, once-in-a-decade opportunity to get some great buys.

Pick almost any listed stock and do the math. Earnings of 7 to 8% are readily available in companies that are solid and growing; earnings of 5% are readily available in companies that are expected to grow rapidly (say 10% annual growth or more) over the next few years. Dividends of 3 to 4% are easy to find as well. Some stocks are so oversold that buying now should result in 50% to 100% total returns over a two year period.

But no one wants to be the chump who buys today just because a stock is a bargain, when it might be even more of a bargain tomorrow. That is the problem with auction prices: they are usually out of equilibrium.

A good strategy is to spread your buys over 2008. Predicting the bottom for the market is guesswork; for individual stocks there is no telling either.

If you buy in a linear fashion over the year you will get some stocks at rock bottom and all your stocks at less than they should be going for. When liquidity returns and valuations go back to normal, whether than be in Q3 2008 or Q3 2009, you'll be glad of the apparent risks you are taking now.

Earnings reporting season is upon us. I'll be posting regularly on the stocks I follow (see list), analyzing Q4 2007 and guessing at what 2008 will bring.

Don't get too excited about any one stock; always diversify (I have to remind myself of that, as much as anyone). It is a good time to buy a house, too, if you are planning to live in it. Except in a few special markets I don't think housing prices have declined enough to make them attractive to investors, given the exceptionally high real-estate transaction costs.

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